Rachel Reeves has been delivered another major blow ahead of next month’s make-or-break Budget as the International Monetary Fund (IMF) warned inflation will surge to the highest in the G7 in 2025 and 2026.
The beleaguered chancellor has struggled to foster the economic growth promised when Labour was elected last year, and the latest outlook report suggests British households will face the fastest-growing costs among the G7 group of advanced economies, driven in part by rising food and hospitality prices.
Its report, described as “grim”, casts doubt on the Bank of England’s hopes of bringing interest rates back down to the 2 per cent target rate in the near future.
Higher interest rates could also increase the size of the black hole in the public finances, already estimated to be between £30bn and £40bn, by adding pressure to increase pensions in line with the triple lock guarantee, as well as upping the risk of public sector pay demands.
The IMF said price inflation in the UK would increase more sharply than previous predictions in July; it now expects UK inflation to average at 3.4 per cent in 2025, rather than 3.2 per cent, and 2.5 per cent in 2026 next year, up from 2.3 per cent.
It also trimmed its growth prediction for 2026 amid concerns over the jobs market – but raised its forecast for this year.
It comes after group of leading economists described Ms Reeves’s situation as “desperate”, with senior Labour ministers split over whether to impose wealth taxes or break manifesto pledges on income tax, VAT or employee national insurance in next month’s Budget.
Leading expert Dan Neidle, founder of Tax Policy Associates, said on Tuesday the “wise” way for Ms Reeves to proceed would be “raising one of the main taxes, possibly by expanding the base of VAT, which may or may not break a manifesto pledge”.
He warned that the “less wise way to do it is by picking from a Scrabble bag of lots of little tax rises”.
Recent figures from the Office for National Statistics show UK consumer prices index (CPI) inflation struck 3.8 per cent in July and August – the highest level since January 2024. The stubborn inflation has been linked in particular to food and hospitality prices, with businesses and industry groups blaming higher labour costs and taxes.
Meanwhile, the UK economy is expected to grow by 1.3 per cent this year, after being boosted by strong growth in the first half; it represents an improvement against the previous IMF forecast of 1.2 per cent. However, the IMF has cut its growth prediction for next year from 1.4 per cent to 1.3 per cent, as global trade pressures threaten to have an impact on economies around the world.
Canada and France also saw their growth projections reduced amid the fallout from higher tariffs, while the US saw its forecast rise slightly. Global growth for this year has also been upgraded from 3 per cent to 3.2 per cent in the report, with many economies proving to be more resilient than expected in the face of tariff increases.
IMF chief economist Pierre-Olivier Gourinchas said Britain “is doing something right in terms of growth”, but that inflation “looks like it’s moving in the wrong direction. “
Tory shadow chancellor, Sir Mel Stride, said: “The IMF assessment makes for grim reading. Inflation in the UK is now set to be the highest in the G7 this year and next – rising faster than expected because of the choices Rachel Reeves has made.
“Since taking office, Labour have allowed the cost of living to rise, debt to balloon, and business confidence to collapse to record lows. Taxes are rising to record highs, and families are being squeezed from all sides. Labour should be getting spending under control to bring down borrowing and avoid damaging tax rises, but Starmer and Reeves are simply too weak to do it.”
But Ms Reeves seized the improved growth estimates to inject a note of optimism. She said: “This is the second consecutive upgrade to this year’s growth forecast from the IMF. It’s no surprise, Britain led the G7 in growth in the first half of this year, and average disposable income is up £800 since the election.
“But know this is just the start. For too many people, our economy feels stuck. Working people feel it every day, experts talk about it, and I am going to deal with it.”
